Depreciation gains to diminish for investors

Negative gearing may be a sacred cow, but it seems depreciation is not. While home owners are now sleeping easier knowing that another interest rate rise is unlikely, potential property investors who don't buy soon are in for a rude shock.

From July 1 the cashflow generated by depreciation will dry up. This is significant as it has helped to sustain the residential investment market as vacancy rates rise and yields sag.

This week the Australian Tax Office circulated a proposed determination that will change the effective life of many items in an investment property. This alters the rate of depreciation investors can claim as a tax deduction. The changes will be in place for the next financial year and will apply only to properties purchased after July 1.

Depreciation experts say the move will reduce the deductions available to investors by as much as 25 per cent. Smaller deductions reduce the cashflow most investors use to help finance the property.

Nicola Woodward, a director of tax depreciation consultancy Apex Property Consulting, predicts the changes could wipe off as much as 1 per cent from residential yields, which are already lower than other forms of investments such as shares.

In the 2000-01 financial year, Australia's 1.3 million property investors told the ATO that expenditure exceeded income generated from their investments by about $700 million.

Australia is one of the few countries in the world that allows investors to offset the cost of investments against their taxable income through both negative gearing and depreciation. That is, all taxpayers subsidise the nation's property investors.

Depreciation was introduced as a pay-off by the Keating government when it introduced capital gains tax in 1985.

There are two depreciation schedules. One relates to the building itself and includes items such as lifts and swimming pools, while the other covers fixtures like carpeting and lighting.

Experts say the move will reduce the deductions available to investors by as much as 25 per cent.

For contracts exchanged after July 1, the effective life of items like the pool filtration system will be extended, while the life of other items is reduced.

Both Apex Property's Nicola Woodward and Scott Brunsdon of Depreciator.com welcome the changes as they remove the "grey areas", but Brunsdon warns there will be losers in the short term.

"If someone buys an apartment off the plan after July 1, they are probably going to be disadvantaged," Brunsdon said.

"They will find there is less depreciation available compared with if they bought today.

"People who buy a five-year-old house are going to find they can claim more depreciation because things like ovens and washing machines now depreciate a lot more quickly."

Crunching the numbers, he said an investor who owns an older-style house in Burwood can claim $11,432 in depreciation under the new rules against $10,584 under the current rules, an 8.01 per cent increase in the first year.

However for someone who buys a new two-bedroom apartment in the Docklands, the amount they can claim will fall by 7.51 per cent to $14,128 in the first year and by 4.96 per cent in the fourth year.

Still, over 40 years, the investors will break-even, Brunsdon said.

"They still get it back in the end but only if they hang around for 40 years."